Many economists tell the story of how banking started, but few question the underlying ethics of what banks do.

First, here's the story of how banking started.Once upon a time there was a goldsmith who made lots of pretty things for people. He built a room with very strong walls and locks to protect his gold at night. No one ever stole his gold.

Villagers noticed his success and asked him to keep their gold safe, too. He said "OK, here's what I'll do. I'll charge you rent for the space you use in my vault, and I'll give you a receipt for the ounces of gold I store for you." This experiment worked and the villagers were happy. Eventually other goldsmiths throughout the land started gold storage businesses too, and it became common practice.

One day, a farmer needed to buy a cow right away. His neighbor had the perfect cow for sale, and the farmer had the right amount of gold, but it was stored with the goldsmith, who lived pretty far away. He told his neighbor he had enough gold, and asked if he would take his gold deposit receipt rather than make him travel all the way into town. The neighbor said "OK, but sign the receipt so that the goldsmith knows you gave it to me."

The arrangement worked like magic! A few weeks later the neighbor went into town and showed the goldsmith the signed receipt. The goldsmith trusted the neighbor and the farmer, and gave the neighbor the farmer's gold. He also stopped charging rent for the gold. Villagers heard about this and also started to buy things with their goldsmith deposit notes.

To make things easier, goldsmith deposit notes eventually were written in standard quantities. This way, portions of stored gold could be exchanged in exact proportion to the cost of what was being bought. Eventually standardized goldsmith deposit notes were commonly exchanged instead of gold.

Everyone was happy with this approach. Why? Because everyone knew what was going on. There was nothing secret or underhanded about the use of gold deposit receipts instead of actual gold. Everyone benefited: buying and selling was easier, and the person who ran the gold vault was rewarded with vault rent payments.

But then things started to change. To find out more, read "Is Banking Ethical? Part 2"